Over the last couple of years, futurisation has been one of the buzzwords that market observers have debated upon. While it is clear that regulators want to shift parts of the Over-The-Counter (OTC) business on exchange, the reality looks different. The OTC market does not shrink. So, what happened to the large-scale replacement of swaps by futures that many expected to follow the global financial crisis?
The answer is that it takes longer than expected. However, a combination of the regulatory agenda and the current market environment finally lays the ground for successful real-life cases of futurisation. One prominent example is Eurex‘s Total Return Futures (TRF).
Launched at the end of 2016, TRF on the EURO STOXX 50® Index support the market in complying with new financial market legislation. Under the Basel III capital standards, banks face increased capital requirements when entering OTC transactions. In addition, the regulator introduced bilateral margin rules on non-cleared swaps.
In combination with cost pressure all over the financial industry, these rules change the structure of derivatives markets by supporting the trend to Exchange Traded Derivatives (ETD). Eurex’s TRF offer returns analogous to Total Return Swaps; thus representing a functional replacement for these OTC instruments.
On November 30 2017, Eurex reached an important TRF milestone with 500,000 traded contracts. In total over €19bn in notional value has traded and open interest is over 10bn.
"The introduction of our Total Return Futures is clearly one of my highlights of the last 12 months", said Eurex CEO Thomas Book. "We estimate that over 10% of the market has already migrated to our listed product. This success shows that regulation opens up new potential for innovation, and how exchanges can support both the market and the regulatory agenda.“
The TRF contract design replicates the pay-out profile of the funded purchase of a cash equities basket representing the components of the underlying index. In line with current market convention, TRF trade in „spread“ in basis points and allow the implied repo rate associated with cash basket replication to be hedged and traded for the first time. Going forward, we can broaden this product structure towards other indices, equity baskets or even other asset classes.
One of the key arguments for ETD like TRF is their standardisation. Contracts that offset each other can be netted out through clearing, offer cross-margining, and the processing of trades is greatly simplified. On top, Eurex Clearing acts as Central Counterparty, mitigating counterparty risks. "That is one of the reasons why market participants have adopted to the product so quickly", Book adds.
Eurex constantly observes market developments and trends. "We are in close contact with our customers as well as regulators. This is key for our objective to meet the market’s needs", said Book. "Also, it is important to stress that we cannot innovate all alone. We work closely with our clients. For our Total Return Futures, BNP as one of our trusted partners gave us valuable input and joined from launch as one major liquidity provider – and therewith an important contributor to this success."
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